Fair Value
Certain assets and liabilities are measured at fair value in the Consolidated Financial Statements or have fair values disclosed in the Notes to the Consolidated Financial Statements. These assets and liabilities are classified into one of three levels of a hierarchy defined by GAAP. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement is categorized in its entirety based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
The fair value hierarchy is summarized as follows:
Level 1 — Quoted prices (unadjusted) for identical assets/liabilities in active markets.
Level 2 — Other observable inputs, either directly or indirectly, including:
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• | Quoted prices for similar assets/liabilities in active markets; |
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• | Quoted prices for identical or similar assets/liabilities in non-active markets (e.g., few transactions, limited information, non-current prices, high variability over time); |
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• | Inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, implied volatilities, credit spreads); and |
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• | Inputs that are corroborated by other observable market data. |
Level 3 — Unobservable inputs that cannot be corroborated by observable market data.
Transfers between levels, if any, are recorded as of the beginning of the reporting period in which the transfer occurs; there were no transfers between Levels 1, 2 or 3 of any financial assets or liabilities during the years ended December 31, 2013 or 2012.
Non-financial assets and liabilities or financial assets and liabilities that are measured at fair value on a nonrecurring basis are subject to fair value adjustments only in certain circumstances, such as when the Company records an impairment. There were no significant fair value adjustments for these assets and liabilities recorded during the years ended December 31, 2013, 2012, or 2011.
The following methods and assumptions were used to estimate the fair value and determine the fair value hierarchy classification of each class of financial instrument included in the tables below:
Cash and Cash Equivalents. The carrying value of cash and cash equivalents approximates fair value as maturities are less than three months. Fair values of cash equivalent instruments that do not trade on a regular basis in active markets are classified as Level 2.
Debt and Equity Securities. Fair values of debt and equity securities are based on quoted market prices, where available. The Company obtains one price for each security primarily from a third-party pricing service (pricing service), which generally uses quoted or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, and, if necessary, makes adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, benchmark yields, credit spreads, default rates, prepayment speeds and non-binding broker quotes. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to prices reported by a secondary pricing source, such as its custodian, its investment consultant and third-party investment advisors. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. The Company’s internal price verification procedures and reviews of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
Fair values of debt securities that do not trade on a regular basis in active markets but are priced using other observable inputs are classified as Level 2.
Fair value estimates for Level 1 and Level 2 equity securities are based on quoted market prices for actively traded equity securities and/or other market data for the same or comparable instruments and transactions in establishing the prices.
The fair values of Level 3 investments in venture capital portfolios are estimated using a market valuation technique that relies heavily on management assumptions and qualitative observations. Under the market approach, the fair values of the Company’s various venture capital investments are computed using limited quantitative and qualitative observations of activity for similar companies in the current market. The Company’s market modeling utilizes, as applicable, transactions for comparable companies in similar industries and having similar revenue and growth characteristics; and similar preferences in their capital structure. Key significant unobservable inputs in the market technique include implied earnings before interest, taxes, depreciation and amortization (EBITDA) multiples and revenue multiples. Additionally, the fair values of certain of the Company’s venture capital securities are based off of recent transactions in inactive markets for identical or similar securities. Significant changes in any of these inputs could result in significantly lower or higher fair value measurements.
Throughout the procedures discussed above in relation to the Company’s processes for validating third-party pricing information, the Company validates the understanding of assumptions and inputs used in security pricing and determines the proper classification in the hierarchy based on that understanding.
AARP Program-related Investments. AARP Program-related investments consist of debt and equity securities held to fund costs associated with the AARP Program and are priced and classified using the same methodologies as the Company’s debt and equity securities.
Interest Rate and Currency Swaps. Fair values of the Company’s swaps are estimated using the terms of the swaps and publicly available information including market yield curves. Because the swaps are unique and not actively traded but are valued using other observable inputs, the fair values are classified as Level 2.
Long-term Debt. The fair value of the Company’s long-term debt is estimated and classified using the same methodologies as the Company’s investments in debt securities.
AARP Program-related Other Liabilities. AARP Program-related other liabilities consist of liabilities that represent the amount of net investment gains and losses related to AARP Program-related investments that accrue to the benefit of the AARP policyholders.
The following table presents a summary of fair value measurements by level and carrying values for items measured at fair value on a recurring basis in the Consolidated Balance Sheets excluding AARP Program-related assets and liabilities, which are presented in a separate table below:
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| | | | | | | | | | | | | | | | |
(in millions) | | Quoted Prices in Active Markets (Level 1) | | Other Observable Inputs (Level 2) | | Unobservable Inputs (Level 3) | | Total Fair and Carrying Value |
December 31, 2013 | | | | | | | | |
Cash and cash equivalents | | $ | 7,005 |
| | $ | 271 |
| | $ | — |
| | $ | 7,276 |
|
Debt securities - available-for-sale: | | | | | | | | |
U.S. government and agency obligations | | 1,750 |
| | 445 |
| | — |
| | 2,195 |
|
State and municipal obligations | | — |
| | 6,977 |
| | — |
| | 6,977 |
|
Corporate obligations | | 25 |
| | 7,274 |
| | 36 |
| | 7,335 |
|
U.S. agency mortgage-backed securities | | — |
| | 2,218 |
| | — |
| | 2,218 |
|
Non-U.S. agency mortgage-backed securities | | — |
| | 696 |
| | 6 |
| | 702 |
|
Total debt securities - available-for-sale | | 1,775 |
| | 17,610 |
| | 42 |
| | 19,427 |
|
Equity securities - available-for-sale | | 1,291 |
| | 12 |
| | 269 |
| | 1,572 |
|
Total assets at fair value |
| $ | 10,071 |
| | $ | 17,893 |
| | $ | 311 |
| | $ | 28,275 |
|
Percentage of total assets at fair value | | 36 | % | | 63 | % | | 1 | % | | 100 | % |
Interest rate swap liabilities | | $ | — |
| | $ | 163 |
| | $ | — |
| | $ | 163 |
|
December 31, 2012 | | | | | | | | |
Cash and cash equivalents | | $ | 7,615 |
| | $ | 791 |
| | $ | — |
| | $ | 8,406 |
|
Debt securities - available-for-sale: | | | | | | | | |
U.S. government and agency obligations | | 1,752 |
| | 786 |
| | — |
| | 2,538 |
|
State and municipal obligations | | — |
| | 6,667 |
| | — |
| | 6,667 |
|
Corporate obligations | | 13 |
| | 7,185 |
| | 11 |
| | 7,209 |
|
U.S. agency mortgage-backed securities | | — |
| | 2,238 |
| | — |
| | 2,238 |
|
Non-U.S. agency mortgage-backed securities | | — |
| | 568 |
| | 6 |
| | 574 |
|
Total debt securities - available-for-sale | | 1,765 |
| | 17,444 |
| | 17 |
| | 19,226 |
|
Equity securities - available-for-sale | | 450 |
| | 3 |
| | 224 |
| | 677 |
|
Interest rate swap assets | | — |
| | 14 |
| | — |
| | 14 |
|
Total assets at fair value | | $ | 9,830 |
| | $ | 18,252 |
| | $ | 241 |
| | $ | 28,323 |
|
Percentage of total assets at fair value | | 35 | % | | 64 | % | | 1 | % | | 100 | % |
Interest rate and currency swap liabilities | | $ | — |
| | $ | 14 |
| | $ | — |
| | $ | 14 |
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The following table presents a summary of fair value measurements by level and carrying values for certain financial instruments not measured at fair value on a recurring basis in the Consolidated Balance Sheets:
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(in millions) | | Quoted Prices in Active Markets (Level 1) | | Other Observable Inputs (Level 2) | | Unobservable Inputs (Level 3) | | Total Fair Value | | Total Carrying Value |
December 31, 2013 | | | | | | | | | | |
Debt securities - held-to-maturity: | | | | | | | | | | |
U.S. government and agency obligations | | $ | 182 |
| | $ | — |
| | $ | — |
| | $ | 182 |
| | $ | 181 |
|
State and municipal obligations | | — |
| | — |
| | 28 |
| | 28 |
| | 28 |
|
Corporate obligations | | 47 |
| | 9 |
| | 278 |
| | 334 |
| | 334 |
|
Total debt securities - held-to-maturity | | $ | 229 |
| | $ | 9 |
| | $ | 306 |
| | $ | 544 |
| | $ | 543 |
|
Long-term debt and other financing obligations | | $ | — |
| | $ | 16,602 |
| | $ | — |
| | $ | 16,602 |
| | $ | 15,745 |
|
December 31, 2012 | | | | | | | | | | |
Debt securities - held-to-maturity: | | | | | | | | | | |
U.S. government and agency obligations | | $ | 174 |
| | $ | — |
| | $ | — |
| | $ | 174 |
| | $ | 168 |
|
State and municipal obligations | | — |
| | 1 |
| | 29 |
| | 30 |
| | 30 |
|
Corporate obligations | | 10 |
| | 346 |
| | 287 |
| | 643 |
| | 641 |
|
Total debt securities - held-to-maturity | | $ | 184 |
| | $ | 347 |
| | $ | 316 |
| | $ | 847 |
| | $ | 839 |
|
Long-term debt | | $ | — |
| | $ | 17,034 |
| | $ | — |
| | $ | 17,034 |
| | $ | 15,167 |
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The carrying amounts reported in the Consolidated Balance Sheets for other current financial assets and liabilities approximate fair value because of their short-term nature. These assets and liabilities are not listed in the table above.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows: |
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| | December 31, 2013 | | December 31, 2012 | | December 31, 2011 |
(in millions) | | Debt Securities | | Equity Securities | | Total | | Debt Securities | | Equity Securities | | Total | | Debt Securities | | Equity Securities | | Total |
Balance at beginning of period | | $ | 17 |
| | $ | 224 |
| | $ | 241 |
| | $ | 208 |
| | $ | 209 |
| | $ | 417 |
| | $ | 141 |
| | $ | 208 |
| | $ | 349 |
|
Purchases | | 38 |
| | 71 |
| | 109 |
| | 11 |
| | 71 |
| | 82 |
| | 92 |
| | 35 |
| | 127 |
|
Sales | | (10 | ) | | (25 | ) | | (35 | ) | | — |
| | (34 | ) | | (34 | ) | | — |
| | (17 | ) | | (17 | ) |
Settlements | | — |
| | — |
| | — |
| | (1 | ) | | — |
| | (1 | ) | | (25 | ) | | (7 | ) | | (32 | ) |
Net unrealized losses in accumulated other comprehensive income | | (2 | ) | | (7 | ) | | (9 | ) | | — |
| | (14 | ) | | (14 | ) | | — |
| | (4 | ) | | (4 | ) |
Net realized (losses) gains in investment and other income | | (1 | ) | | 6 |
| | 5 |
| | — |
| | 13 |
| | 13 |
| | — |
| | (6 | ) | | (6 | ) |
Transfers to held-to-maturity | | — |
| | — |
| | — |
| | (201 | ) | | (21 | ) | | (222 | ) | | — |
| | — |
| | — |
|
Balance at end of period | | $ | 42 |
| | $ | 269 |
| | $ | 311 |
| | $ | 17 |
| | $ | 224 |
| | $ | 241 |
| | $ | 208 |
| | $ | 209 |
| | $ | 417 |
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The following table presents quantitative information regarding unobservable inputs that were significant to the valuation of assets measured at fair value on a recurring basis using Level 3 inputs: |
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| | | | | | | | Range |
(in millions) | | Fair Value | | Valuation Technique | | Unobservable Input | | Low | | High |
December 31, 2013 | | | | | | | | | | |
Equity securities - available-for-sale | | | | | | | | | | |
Venture capital portfolios | | $ | 233 |
| | Market approach - comparable companies | | Revenue multiple | | 1.0 | | 6.0 |
| | | | | | EBITDA multiple | | 8.0 | | 9.0 |
| | 36 |
| | Market approach - recent transactions | | Inactive market transactions | | N/A | | N/A |
Total equity securities available-for-sale | | $ | 269 |
| | | | | | | | |
Also included in the Company’s assets measured at fair value on a recurring basis using Level 3 inputs were $42 million of available-for-sale debt securities at December 31, 2013, which were not significant.
The Company elected to measure the entirety of the AARP Assets Under Management at fair value pursuant to the fair value option. See Note 2 for further information on the AARP Program. The following table presents fair value information about the AARP Program-related financial assets and liabilities:
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| | | | | | | | | | | | |
(in millions) | | Quoted Prices in Active Markets (Level 1) | | Other Observable Inputs (Level 2) | | Total Fair and Carrying Value |
December 31, 2013 | | | | | | |
Cash and cash equivalents | | $ | 265 |
| | $ | — |
| | $ | 265 |
|
Debt securities: | | | | | | |
U.S. government and agency obligations | | 426 |
| | 301 |
| | 727 |
|
State and municipal obligations | | — |
| | 63 |
| | 63 |
|
Corporate obligations | | — |
| | 1,145 |
| | 1,145 |
|
U.S. agency mortgage-backed securities | | — |
| | 414 |
| | 414 |
|
Non-U.S. agency mortgage-backed securities | | — |
| | 139 |
| | 139 |
|
Total debt securities | | 426 |
| | 2,062 |
| | 2,488 |
|
Equity securities - available-for-sale | | — |
| | 4 |
| | 4 |
|
Total assets at fair value | | $ | 691 |
| | $ | 2,066 |
| | $ | 2,757 |
|
Other liabilities | | $ | 3 |
| | $ | 11 |
| | $ | 14 |
|
December 31, 2012 | | | | | | |
Cash and cash equivalents | | $ | 230 |
| | $ | — |
| | $ | 230 |
|
Debt securities: | | | | | | |
U.S. government and agency obligations | | 545 |
| | 244 |
| | 789 |
|
State and municipal obligations | | — |
| | 51 |
| | 51 |
|
Corporate obligations | | — |
| | 1,118 |
| | 1,118 |
|
U.S. agency mortgage-backed securities | | — |
| | 427 |
| | 427 |
|
Non-U.S. agency mortgage-backed securities | | — |
| | 155 |
| | 155 |
|
Total debt securities | | 545 |
| | 1,995 |
| | 2,540 |
|
Equity securities - available-for-sale | | — |
| | 3 |
| | 3 |
|
Total assets at fair value | | $ | 775 |
| | $ | 1,998 |
| | $ | 2,773 |
|
Other liabilities | | $ | 23 |
| | $ | 58 |
| | $ | 81 |
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